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America's Financial Mess

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Wotan

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I haven't read this whole thread, though I have been keeping up with others on this topic. I certainly don't think we ought to be hoping for a meltdown to spark a very unlikely event that the government will take the blame for it and thus we will get more freedom out of it. I just don't see that happening at this time.

However, there are some politicians fighting against the proposed bail-out / mortgage takeover.

From this news story:

"Crisis is a term that is used far too often in Washington, but this is one of the few times that I believe those using it," Rep. Jeb Hensarling, a Texas Republican, said Friday in a written statement. "At such a critical moment for our nation, careful, sober, and thoughtful reflection and rhetoric is required."

and further:

"At this point, Congress is being asked to support an uncertain entity, costing an uncertain amount of dollars, for an uncertain duration," he said. "My fear is that taxpayers will be left with the mother of all debts, the federal government becomes the lender and guarantor of last resort, and our nation finds itself on the slippery slope to socialism."

Not that I think the Republicans understand the issue fully, because if they did there would be an immediate reversal of the laws that got us here in the first place, such as killing the Community Reinvestment Act, which no one in our government has bother stating. Nobody in government wants to tell these people that you are not permitted to have a home because you cannot afford one; and the American people are not going to buy you one with their tax dollars.

We'll have to see how this all works out by Monday or Tuesday; but keeping the same laws and having even more regulations will definitely do much more harm. What they are attempting to do is to bypass an economic fuse, that if not permitted to correct itself on the free market may wind up short circuiting the entire economy.

I hope not, as I don't see any clues by our government that we won't lose our freedoms in the process. And I don't see enough of the voters (if any in the news) complaining that the government did it. We know that is what happened, and there are some financial leaders that know it too; but if capitalism takes the blame, then the people are going to be speaking out for their homes they can't afford even if it leads to socialism. In other words, I haven't seen any of these poor home owners saying they would rather have freedom and lose their house, if necessary -- have you?

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In good news, there is one responsible columnist in the entire 'The Times' newspaper here: http://blogs.telegraph.co.uk/philip_booth/...he_money_supply

He came to my awareness via this article. I like him. :)

And he uses the decidedly British expression "caused quite a rumpus" which always makes me smile!

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Jeff Frankel, former economics advisor to Bill Clinton and current Harvard professor of government, etc. says:

“They say there are no atheists in foxholes. Perhaps, then, there are also no libertarians in financial crises.”

Well, I'm one, pal! :) I want all those Big Finance companies declared bankrupt. Have them declare Chapter 11, followed by an orderly sell-off of their assets -- probably for 80 cents on the dollar or so (but no less). Then some good and savvy company will take them over, and the economy will probably boom in a few years, with many great business innovators. But this will happen far less with all these "rescues." The Microsofts, Googles, Wal-Marts, and Staples of the future will never be born -- due to all this evil government "help."

I, for one, simply do not believe "the system" is in danger of "collapsing." No potential "meltdowns" loom on the horizon.

Laissez-faire! and let all those incompetent financial companies immediately die. :nuke:

Edited by Wotan
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Let Warren Buffet , the "wizard of Omaha," take over this new US super-regulatory agency! In today's economic hard-times, he's flush with cash. And he was well-grounded enough to avoid the bursting of both the internet and the housing bubbles! Who else on this earth was that smart? Warren Buffet for our new High Finance czar! :)

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I think it is needless to say on this forum, but no we don't need a treasury secretary czar to get involved in this mess -- what we need is free markets to buy up those foreclosed homes dirt cheap and then sell them at a profit. Sure, the housing market would come down, as what always happens when goods are dumped on the market, but if they want houses to go to poor people, then stop propping up the housing market and there will be plenty of homes that could be bought at low prices. However, they are not doing that, they want to prop up the housing market at the cost of $700 billion dollars!

And not only that, they really do want to create a Czar:

While the proposal contains no requirement that the government receive anything from banks in return for unloading their bad assets, it would allow the Treasury Department to designate financial institutions as "agents of the government," and mandate that they perform any "reasonable duties" that might entail.

Uh...reasonable would be to get the government out of the markets; but to them, "reasonable" means whatever they deem is beneficial to the people, whatever the hell that means.

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I think it is needless to say on this forum, but no we don't need a treasury secretary czar to get involved in this mess...

TMM -- I agree! But if a new ultra-powerful gov't agency is going to be created, as seems hugely likely, then we might as well have it run by pretty much the one guy on earth who wasn't suckered by the housing bubble. A good man like Buffet may save us hundreds of billions of dollars! :)

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TMM -- I agree! But if a new ultra-powerful gov't agency is going to be created, as seems hugely likely, then we might as well have it run by pretty much the one guy on earth who wasn't suckered by the housing bubble. A good man like Buffet may save us hundreds of billions of dollars! :)

And maybe the Obama administration can grant him immortality!

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TMM -- I agree! But if a new ultra-powerful gov't agency is going to be created, as seems hugely likely, then we might as well have it run by pretty much the one guy on earth who wasn't suckered by the housing bubble. A good man like Buffet may save us hundreds of billions of dollars! :)

Well, I don't think a rational man would accept that type of position with the government. If you recall, John Galt of Atlas Shrugged was offered that position, and he recommended that the government get out of the economy, and they wouldn't comply -- so he turned them down. Besides, it would have been an insult to his industrial buddies to have taken that kind of power over them; and the whole reason for the strike was to set him and other creators free of government manipulations.

Also, while Warren Buffet is very good at making money, he didn't foresee the revolution offered by the Internet, and if he had the power he might not have approved it. I also don't see the evidence that he is for free markets, but if you have a quote regarding that, I'd like to see it :nuke:

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Here is another news story that will turn your heads. Evidently, McCain is all for free markets, at least according to Obama:

"As big government steps in to bail out Wall Street, Barack Obama is ridiculing his rival as a free-market buccaneer who until this week was the champion of the kind of deregulation blamed for the economic meltdown."

Oh, really? :)

Obama said of McCain: “There’s only one candidate who called himself, and I quote, ‘fundamentally a deregulator,’ when it was reckless deregulation and lack of oversight that’s a big part of the problem on Wall Street right now,” he said in Jacksonville, Fla., calling McCain the “great deregulator.”

I only wish it were true that McCain would be all out for deregulation and hence get the nome-de-plume of "The Great Deregulator"!

Sometimes, I don't know whether to laugh or to cry when Presidential candidates speak.

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I only wish it were true that McCain would be all out for deregulation and hence get the nome-de-plume of "The Great Deregulator"!

Obama's recent anti-capitalist comments demonstrate how the concept of Capitalism has been twisted and distorted in the common political culture. McCain, who is surely a statist and who frequently criticizes "greed" and businessmen, is not a deregulator in any rational use of that term. As I listen to the two very imperfect presidential candidates and watch this fiasco unfold, I continue to be struck by its parallels to the Great Depression. Here's an interesting opinion piece on that same topic:

http://www.unionleader.com/article.aspx?he...a5-be733a3d84f3

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TMM -- I agree! But if a new ultra-powerful gov't agency is going to be created, as seems hugely likely, then we might as well have it run by pretty much the one guy on earth who wasn't suckered by the housing bubble. A good man like Buffet may save us hundreds of billions of dollars! :o

Absolutely not. This has already happened. For the last 20 years Alan Greenspan has had control of the FED, and most might say he did a pretty good job. But today, is govt intervention blamed for the financial mess or capitalism? I think having govt regulation "run efficiently" by a capitalist is the worst thing we can do for the cause. Let em experience the true implications of their policies.

Edited by KendallJ
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I was at a party last night and had the opportunity to hold a captive audience about the current economic issues. It was actually quite cool. It's the first time I've ever had such a chance, and I guess it's because this party was mainly populated by people two or three times my age, and so with slightly more... perspective, and patience.

I explained why short-selling was good (which another guy agreed with entirely), why the CRA caused all the bad loans to be made, why inflation of the money supply disguised what was really going on in the economy and that government regulation in general forced people to make incredibly bad investments and try and then bundle them up and get rid of them some how. I don't think I entirely convinced anyone, but I made my little impact on public opinion.

I've got to say, one comment I still get is, 'The regulation wasn't that significant', one argument I can't argue against because, well, then you have to get really in depth, right, showing how changes in the market happened directly as a result of gov. regulation?

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I've got to say, one comment I still get is, 'The regulation wasn't that significant', one argument I can't argue against because, well, then you have to get really in depth, right, showing how changes in the market happened directly as a result of gov. regulation?
I think "regulation" is the wrong term to use. "Interference" is broader, but more accurate. The government sets up a system with certain "incentives" and regulations. I use the term "incentive" to mean: inducements to act in ways one would not otherwise act (while regulation is to stop people from acting in ways they would otherwise act).

For instance, when the government does not completely spin off Fannie and Freddie, but instead treats them differently (with their own special regulator and congressional oversight), it gives people the impression that it will stand behind those companies in some way, and definitely more than it stands behind any other big private financial company. As a result, perceiving this additional safety, lenders are willing to lend to Fannie at rates that are lower than they would lend to a typical private company. So, "sponsoring" Fannie and Freddie, acts as an incentive. It means cheaper money for Fannie and Freddie, and cheaper loans to their customers: Joe Smith of main street. It also means private competitors are driven out of that business. It also means Joe Smith buys a little more house than he could afford if the ultimate lender (beyond Fannie/Freddie's intermediation) was not assuming government support. This means more capital in the U.S. flows into certain types of residential housing than into other areas.

These incentives are the cause a classic mis-direction of capital. The realization that the misdirection has taken place, then causes a reversal, and a recession.

Edited by softwareNerd
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OK. So now what happens? The government has stepped in to the tune of $1,000,000,000,000 or so, so what does it mean? What is going to be the result of this intervention?

It means that the credit market, which was dried up by the collapse of the mortgage industry, has received additional money to allow for all the other things that need credit. The most imminent threat was in the money market funds, which were threatened with a run Thursday morning due to the perception among fund investors that those normally safe funds might go under with the wave of bank failures. The Treasury essentially nationalized the money market, after having nationalized the mortgage market and a good chunk of the insurance market. Money market is a pool of cash used for short term loans by companies for bridging the gap between the purchase and sale of resources. A tightening in the money market will shut down a great deal of the productive capacity of many companies. Production will crash, people with debt will get laid off, mortgages, credit cards, etc. default, and the circle of doom spreads.

Make no mistake, we were in a full credit meltdown Thursday morning until the Treasury promised $100B of quick money market liquidity. That gains some time until the market calculates (through the mechanism of price signals) whether or not this injection will have the desired effect. It is interesting and disturbing to note that the Treasury acknowledged this fact when they shunted one of the most effective mechanisms behind price signals: short selling. That suppression of market information was required to slow the market's calculation until the Treasury can get one step ahead of it. That should tell us that the Treasury knows that this bail-in will be found by the market to be insufficient or ineffective and further actions will be "necessitated."

In a nutshell, the state is creating unknown long term consequences to gain short term control. You will note that the almost unanimous chorus is that "failure of regulation" led to this state. In a sense, that's true, but what almost no one will tell us, is that it was failure of regulation of the state's actions, not the market's, that has led us to the precipice.

(on edit:)

The nationalization of credit means that the State now has the explicit power to determine, by whim, which business ventures merit credit and which don't. Expect to see a flood of campaign contributions in the months ahead as businesses and special interests jockey to bribe their way onto the life boat.

Edited by agrippa1
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OK. So now what happens? The government has stepped in to the tune of $1,000,000,000,000 or so, so what does it mean? What is going to be the result of this intervention?
Broadly, and in the long-run, it means less prosperity for the U.S. than it would otherwise have seen. Any detailed predictions are primarily political in nature. Ceteris paribus, we're likely to see higher pre-inflation interest rates on long-term U.S Treasuries, and also a higher "inflation-premium". This, inter alia, implies higher mortgages rates and other financing rates; though it might be 2009/10 before this can begin to manifest. It also appears that there will be continued downward pressure on the US$. Chances are that unemployment will continue to rise a bit. The "spring" in the system will be U.S. exporters, which can help restore jobs and the dollar in the longer run -- at the cost of moderated real incomes and real consumption.

One big problem is that "ceteris paribus" is a huge assumption. First, new regulations and witch-hunts might be coming. Apart from being unjust, they would waste a lot of productive energy, and end up shackling business further. Also, it's likely that Obama and McCain will throw some type of enviro-inspired structural shackle over the economy. In addition, government spending will probably continue unabated. And, then, there is the potential backward step that can be caused by a trend toward health-care nationalization. I also assume that the stock market upheaval has killed the hopes of any "privatization" of social security; chances are that both candidates will favor some type of additional "funding" of social-security, simply making the bad system worse.

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And, then, there is the potential backward step that can be caused by a trend toward health-care nationalization.

Indeed, this is a scary prospect. I don't know what the likelihood of full-scale nationalization during one presidential term is, though I'm inclined to say it would be pretty tough to do. Though a more full-blown trend in that direction obviously isn't good, what really scares me is the lose-lose situation we face in regards to pharmaceuticals. BOTH McCain and Obama have been openly hostile to the industry, both want to enact crippling regulations. With a lot of patents about to expire and more hampering down already on the part of the FDA, it looks like pharma is becoming even MORE susceptible to politics rather than market conditions. The turmoil we're experiencing in the financial sector right now is obviously disconcerting, but in my personal opinion, if things keep going the way they are now, we have an even bigger mess awaiting us around the corner in terms of quality of life.

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Here is an interesting news story that puts the blame for the meltdown squarely on the Federal government policy, although it does contain the almost obligatory snide comment against housing speculators.

"The changes in underwriting standards were pushed to accomplish what many called a "noble goal" -- an increase in home ownership among poor and minority Americans -- but the changes created a time bomb that was set off as soon as property values began to decline. The new rules involved eliminating verification of income or assets, little assurance of the ability to pay the mortgage, and virtually eliminating down payments."

However, neither this or any other news story I have read has called for a reversal of the Community Reinvestment Act. Is this acknowledgment of the Fed's role in the mess but having no outrage against the law that made it happen evasion on a massive scale brought about by altruism? Does nobody want to say that those who cannot afford a home ought not to be given a home at anyone else's expense? I currently do not own a home because I cannot afford one, even though some have been offered to me a nearly what I pay for rent; though even a hundred dollars more a month would break me financially.

There is a whole lot of evasion going on out there in order to support this "noble cause".

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The Feds have made another major move late Sunday before the markets open Monday morning, though I'm not sure exactly what it means.

"That change will allow the two venerable institutions [Goldman Sachs and Morgan Stanley] to set up commercial banks that will be able to take deposits, significantly bolstering the resources of both institutions. It will also grant them permanent access to emergency loans supplied by the Fed rather than the temporary loan status they have had since last March when the Fed moved to prop up investment banks following the forced sale of Bear Stearns."

I guess investment banks didn't take in deposits, but rather made their money backing companies, though I am not sure of this.

Of course, in a free market, if investment banks wanted to deal also with traditional banking deposits, they would be free to do so. But, at this time, I cannot assess whether this is a good move or a bad move. I definitely don't like all these Fed deals going down over the weekend when the markets cannot react.

Guess we will see how things go this upcoming week.

Still no word on the Community Reinvestment Act, the root cause of the problem, being struck down.

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I don't know what the likelihood of full-scale nationalization during one presidential term is, though I'm inclined to say it would be pretty tough to do.
From your lips, to the ears of God! :lol: Actually, I'm hoping that voters are in a mood that says: "right now, with the economy what it is, we can't afford any big plans for health-care, nor boondoggles like T.Boone is pushing.

... Still no word on the Community Reinvestment Act, the root cause of the problem, being struck down.
Since the CRA forced banks to lend to risky borrowers, it is obviously a part of the problem. However, what is not clear is this: what % of sub-prime were forced in this way? If it was so large, why are some banks so much more secure -- e.g. Wells Fargo -- when they were working under the same rules? Also, if CRA saddled banks with these risky assets, why did the Wall-street firms get in on the act? Since the CRA has been in place for so many years, why did the proportion of sub-prime grow so rapidly after 2004-05?

I think the "incentives" (low interest rates, Fannie Freddie buying 25% of sub-prime paper) played a bigger role than the "raw" CRA itself.

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From your lips, to the ears of God! laugh.gif Actually, I'm hoping that voters are in a mood that says: "right now, with the economy what it is, we can't afford any big plans for health-care, nor boondoggles like T.Boone is pushing.

Oh man! That would be like Christmas!

Since the CRA forced banks to lend to risky borrowers, it is obviously a part of the problem. However, what is not clear is this: what % of sub-prime were forced in this way? If it was so large, why are some banks so much more secure -- e.g. Wells Fargo -- when they were working under the same rules? Also, if CRA saddled banks with these risky assets, why did the Wall-street firms get in on the act? Since the CRA has been in place for so many years, why did the proportion of sub-prime grow so rapidly after 2004-05?

I think the "incentives" (low interest rates, Fannie Freddie buying 25% of sub-prime paper) played a bigger role than the "raw" CRA itself.

As far as the raw CRA playing a direct role, I am also not sure. And why did the proportion of sub-prime grow so rapidly after 2004? I wonder if it has something to do with the growing prosperity of the credit derivatives market, especially credit default swaps, whose market was twice the size of the stock market by mid-2007. Is it any coincidence that the credit default swap, which is essentially credit insurance, was introduced the same year as the CRA was significantly strengthened?

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From your lips, to the ears of God! Actually, I'm hoping that voters are in a mood that says: "right now, with the economy what it is, we can't afford any big plans for health-care, nor boondoggles like T.Boone is pushing.
It always amazes me that so many people in this country seem to be willing to turn over their healthcare to the same group that gave us the legendary purchasing efficiency of the US Department of Defense as well as the crack team of financial wizards that provided us with the sub-prime mortgage fiasco. Yikes!

Since the CRA forced banks to lend to risky borrowers, it is obviously a part of the problem. However, what is not clear is this: what % of sub-prime were forced in this way? If it was so large, why are some banks so much more secure -- e.g. Wells Fargo -- when they were working under the same rules? Also, if CRA saddled banks with these risky assets, why did the Wall-street firms get in on the act? Since the CRA has been in place for so many years, why did the proportion of sub-prime grow so rapidly after 2004-05?

I think the "incentives" (low interest rates, Fannie Freddie buying 25% of sub-prime paper) played a bigger role than the "raw" CRA itself.

Although the CRA was enacted in 1977, it wasn't until the 1990s that things really picked up steam. The Wikipedia entry on the CRA has some interesting info, although I’m always wary of things in Wikipedia:

"In 1995, as a result of interest from President Bill Clinton's administration, the implementing regulations for the CRA were strengthened by focusing the financial regulators' attention on institutions' performance in helping to meet community credit needs. These revisions[1] with an effective starting date of January 31, 1995 were credited with substantially increasing the number and aggregate amount of loans to small businesses and to low- and moderate-income borrowers for home loans. These changes were very controversial and as a result, the regulators agreed to revisit the rule after it had been fully implemented for seven years. Thus in 2002, the regulators opened up the regulation for review and potential revision.[citation needed]

Part of the increase in home loans was due to increased efficiency and the genesis of lenders, like Countrywide, that do not mitigate loan risk with savings deposits as do traditional banks using the new subprime authorization. This is known as the secondary market for mortgage loans. The revisions allowed the securitization of CRA loans containing subprime mortgages. The first public securitization of CRA loans started in 1997 by Bear Stearns. [2] The number of CRA mortgage loans increased by 39 percent between 1993 and 1998, while other loans increased by only 17 percent. [3] [4]"

From my limited experience with the mortgage industry, I think that what really allowed the sub-prime business to take off was the facilitation of securitizations. This is what made the capital available to all of the independent mortgage brokers and originators who flooded into the market. Unlike traditional banks, they didn’t have core deposits and the state capital requirements (at least here in Michigan) were quite low. These brokers essentially signed people up for mortgages according to the underwriting standards that were acceptable to the securitizers who then bundled them and sold them to financial institutions, businesses, individuals, hedge funds, etc… in the secondary market. If this secondary market had not been made feasible by Fannie and Freddie and the FHA, you would have never had such a tremendous amount of capital pouring into the mortgage business. In fact, prior to the boom in the secondary market, banks were the sole source for mortgages and they frequently retained and serviced the debt that they originated. That being the case, their underwriting standards were far more stringent than what eventually became the norm in the secondary market. We went from banks asking for extensive documentation on the borrower’s income and assets to a situation where no-document loans and loan to value ratios of 110% or higher were common. The key again is that the originators (like Countrywide and thousands of other smaller entities) had limited or virtually no capital so they could have never continued to make these loans if they had not been able to sell them to bundlers who then placed them on the secondary market. Of course the secondary market became huge as a result of the efforts of Fannie & Freddie as well as the implicit guarantee provided by the government to these GSEs. I think this is why so many very smart people were fooled into thinking that the CMOs they were buying were safe. Hey, the government is guaranteeing the paper, right?

Yaron Brook hit the nail on the head in his 7/18/08 Forbes column:

“The government has promoted bad loans not just through the stick of the CRA but through the carrot of Fannie Mae and Freddie Mac, which purchase, securitize and guarantee loans made by lenders and whose debt is itself implicitly guaranteed by the federal government. This setup created an easy, artificial profit opportunity for lenders to wrap up bundles of subprime loans and sell them to a government-backed buyer whose primary mandate was to "promote homeownership," not to apply sound lending standards.

Of course, lenders not only sold billions of dollars in suspect loans to Fannie Mae and Freddie Mac, contributing to their present debacle, they also retained some subprime loans themselves and sold others to Wall Street--leading to the huge banking losses we have been witnessing for months.”

http://www.forbes.com/2008/07/18/fannie-freddie-regulation-oped-cx_yb_0718brook.html

And why did the proportion of sub-prime grow so rapidly after 2004? I wonder if it has something to do with the growing prosperity of the credit derivatives market, especially credit default swaps, whose market was twice the size of the stock market by mid-2007. Is it any coincidence that the credit default swap, which is essentially credit insurance, was introduced the same year as the CRA was significantly strengthened?

That could well be part of the cause. I also think that artificially low interest rates had to play a major role. When rates are low and the market is awash in liquidity, the added return provided by a government guaranteed bundle of sub-prime loans probably started to look pretty attractive to investors.

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A good article from CFO.com on the Lehman bailout:

"The U.S. Bankruptcy Court approved the sale of substantially all the assets of Lehman Brothers Inc., to Barclays Capital just days after the gilded investment bank filed for bankruptcy. Court approval means that the hundreds of thousands of Lehman customer accounts can be transferred without undue interruption, instead of going through a lengthy brokerage liquidation process that can take weeks and impair customer access to cash and securities, the Securities and Exchange Commission pointed out in an announcement.

The transfer of most retail accounts, holding over $100 billion in assets, is expected to be completed within days. The regulator noted that the court's decision followed a marathon 11-hour hearing in a packed Manhattan courtroom."

http://www.cfo.com/article.cfm/12284437?f=alerts

Given the speed with which the bankruptcy court acted on this matter, I wonder why we supposedly need this new RTC-like entity to buy up all of the mortgage backed debt that's floating around. It seems to me that a better solution would be to let the existing bankruptcy system deal with the weak banks and financial companies on an expedited basis as they file for Chapter 11 protection.

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